Non-Governmental Reform

While our attention can be temporarily redirected to more pleasant matters, it does not take long to remember that the banking and financial systems are in need of serious reform.

The most recent episode of irresponsible trading in the US was by Knight Capital Group. The Group instituted a new software system with a glitch that led to a loss of over $400 million in less than an hour of trading. The glitch was the result of the software being put into practice before it could be fully tested. The thought was, if this new software could be implemented ahead of the competition, Knight Capital would gain an edge on its competitors. The rush to beat the competition led to a premature, and thus irresponsible, implementation of its new software. There is no evidence of intentional deception or corruption as was the case with Barclay's, Enron, or MF Global; but it was irresponsible.

Nevertheless, reform does not mean government-led or government-mandated action. Government oversight and intervention are not the answer; a restructuring of how companies operate and reward their employees is. Government reform is always fighting the previous battle. Reforming the way companies operate is the only real response.

The recommendations I make are necessary but not sufficient. I make them not only in consideration of my work as a political theorist and ethicist but also as a result of my experiences as a small business owner who struggles with how to balance profit, ethics, and the law while keeping his employees focused on doing the right thing as they make money.

As long as monetary gain is the motive there will always be corruption and irresponsible behavior, simply because the acquisition of money is not the simple effect of responsible or ethical behavior. We cannot eliminate money or profit. It would be equally foolhardy to think government regulations will do the trick. Whatever restrictions are passed, someone will be waiting to figure out a way around them. But there are three organizational modifications that businesses can make that will help curb abuse and irresponsible behavior. Of course nothing will prevent this sort of behavior entirely, and modifications will always need to be made to keep up with changing times, but what I outline will avoid the false assumptions of government regulation.

First, those in charge of carrying out a company's day-to-day operations should be different from those in charge of managing profit margins. For instance, if a salesperson at a car dealership earns a commission on the cars she sells, she will have no immediate incentive to be honest or fair with the customer. Her goal will be to sell cars at the highest possible price. The same holds true for financial planners. If a planner has to choose between two investments for a client, one that will earn him a higher commission even though it's not the best option for the client, he will be inclined to do so. To say or expect otherwise is naive. Similarly, if those in charge of developing investment software for Knight Capital (not those whose salaries were tied to successful trades) were also in charge of deciding when it was fit to implement, the outcome could have been different. A software engineer making a fixed sum, whose future income will depend on the quality of the software, will have more of an incentive to get it right.

Second, there needs to be transparency. When a firm makes fundamental alterations to business practices or operating procedures, the changes must be submitted to the company's board for approval and made known to all customers and investors whom the changes may affect. Not only will this provide an opportunity for internal checks to keep bad business practices from being put into action but it will make poorly conceived or unethical plans less likely to be presented in the first place. If I know that the changes I make will be open to scrutiny I will be much less likely to act badly.

The third recommendation is delay. When delay procedures are institutionalized, time is available to evaluate any changes in policy or procedure. For instance, if Knight Capital had had a mandatory 90-day evaluation period for any software changes there is a good chance that the most recent fiasco could have been avoided, which would have saved the firm and its investors a lot of money. The SEC already recognizes the benefit of delay, which is why it stops trading whenever a stock drops too drastically in too short of a time. When people are given pause, cooler heads usually prevail.

The recommendations I outline are not a cure-all, but they tap into fundamental issues that must be addressed if any worthwhile reform is to be implemented. Current reform efforts require outside regulation that is generally too slow to adapt and is too easily circumvented. If, however, we change the way companies do business by taking into account how people make decisions, we will be off to a better start.

About this Author

Kyle Scott, Ph.D., teaches political science at the University of Houston and is an elected member of the Board of Trustees for the Lone Star College System. Kyle's most recent book is Federalist Papers: A Reader's Guide. His commentary on current events has appeared in Forbes, Reuters.com, the Christian Science Monitor, Foxnews.com, the Huffington Post, and dozens of local outlets. He can be contacted at kyle.a.scott@hotmail.com.